"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful."
Warren Buffett
We are definitely going through a very interesting time in our economy to say the least. Although there is great uncertainty in the markets, there also seems to be great opportunity. There is a difference between uncertainty and risk. Although, short term investors tend to mistake the two things, uncertainty and risk are not the same. Wall street hates uncertainty and punishes the stocks of good companies along with the stocks of bad companies. This creates a great buying opportunity for the long term investors. I am almost encouraged by this talk about recession. I have no way of predicting a recession or slow down or meltdown, what I do know is that Mr. Market is giving us a dicount on good companies. Instead of shunning stocks completely in down cycles, investors should add to their holdings or create new positions in stocks that have been on their watchlist.I have opened new positions in a couple stocks that I think have the ability to add to my portfolio in the long run. I have been watching these two stocks for about a year and this market decline has convinced me to jump right in and buy shares of these companies. I am buying stocks of companies that I think are best in their class and are trading at multiples much lower than they are truly worth. As Mr. Buffett says in one of his famous letters to his shareholders "be fearful when others are greedy and greedy when others are fearful".
Be fearful when others are greedy and greedy when others are fearful
Different Styles of Investing
You will find Investors usually classify themselves into different categories like Value, Growth, Income, Small-Cap and International. But very rarely will investor classify themselves as short term investors. Almost everyone thinks of themselves as long term investors, even those that check share prices on their cell phones and have ticker symbols on their desktop never admit to being short term investors. Many people do not fall into any one category but draw from different categories to produce a diversified portfolio.
Value Investing
Investors that seek companies that have fallen below what they determine to be the real value or “intrinsic value” of the company. Since the stocks of the companies are selling at a depressed price, they are said to carry a “margin of safety”. Warren Buffett is probably the most famous value investor.
Growth Investing
Investors that invest in fast growing companies with a prospect for fast growth are usually growth investors. It is a much bumpier ride and this kind of investing is not for the faint of heart.
Income Investing
Income Investors usually invest in companies that pay dividend. Most of these companies are well established and have solid balance sheets.
Small-Cap Investing
Small cap investors invest in companies that have a small capitalization and relatively less known than the bigger companies. Since most of the companies are less followed by Wall Street analysts, the potential upside can be very substantial, but it comes with a lot more risk.
International Investing
International investors invest in companies listed outside the United States. More than half the world’s capitalization lies outside the United States.
Paying off your mortgage early vs. Investing in the Stock market
Paying off your mortgage early vs. Investing in the Stock market
If you have ever wondered if you are better off paying off your mortgage early, you are not alone. Many people including yours truly have wondered if it is better in the long run to pay off your mortgage instead of investing in the stock market.
I have come to the conclusion that it truly depends on your time horizon. If you have a long investment horizon, and your mortgage rate is low, investing in the stock market is the way to go. Paying off your mortgage gives you a return of the interest rate that you would pay having the mortgage, i.e. if your mortgage rate is 6%, than your return for paying the mortgage off early is 6% as you are saving that interest on the principal over the term of the loan. You have to bear in mind also that if you pay off the mortgage you lose the mortgage deduction on your federal taxes. You also lose the leverage that real estate provides you. No one I know put 50% down on their homes, the most they put down for a payment was about 20-25% to avoid PMI. The rest was a loan from the bank or Mortgage Company. Furthermore, Real Estate is not the most liquid of assets. If you were to pay off your mortgage and somehow got yourself in a financial pickle, you may not be able to sell your house quickly. You could get a loan against it, but that would bring you back to where you started before you paid off your mortgage.
I understand that investing in the stock market with so many uncertainties like we have now is not easy. The fear of inflation, subprime fears, and geopolitical fears do not make investors sleep easy. But investing in the Stock market for the long term is the best way to creating wealth in the long term. So if you are not retiring in the next few months or years and do not have better alternatives to your money, don’t pay off your mortgage but invest your hard earned dollars in the Stock market and let the power of compounding do its magic over time.
Types of Brokers
Brokers are generally divided into two large categories, Discount brokers and Full Service brokers.
Discount Brokers
Discount Brokers generally do not offer personal advice to individual investors; instead they make money by transacting business mostly online. Most Discount brokerages make money by doing business in volume, offering good customer service and low prices to drive more trades. The Discount Brokers usually offer a smaller number of products than full service brokers and keep their commissions lower to attract business. As an independent investor, I am a big fan of Discount Brokers. I have used TDAmeritrade and Etrade for many years and I am very pleased with their services. There are a number of other Discount Brokers like Scottrade and Sharebuilder as well, which are worth investigating before choosing a Discount Broker. Here is a link to a Broker Comparison Table at the Motley Fool website.
Full Service Brokers
Full Service Brokers usually offer a wide variety of services like Insurance, annuities, stocks, bonds and derivatives. They usually make money by either charging a percentage of assets managed or by taking a flat fee for the assets under management. The brokers who work for full service brokerages work mostly on commission and usually solicit their business. This usually means that it is in their interest to get their customers to trade. They make money whether or not the client makes money or not. I would like to mention that I have never used a full service broker myself and I am basing all the information above on my research. Large investment firms like Merrill Lynch and Smith Barney would qualify as full service brokers.
Since I believe in a do-it-yourself approach to investing and research, I recommend Discount Brokers. As I mentioned before, I have used a couple of discount brokers for the past few years and I am very happy with their level of service. With the explosion of the internet, discount brokers offer a lot more features than in the past, for instance TDAmeritrade offers free research from Standard and Poor’s stock report, which can be very helpful in making investment decisions.
Shelby Davis- A real life success in the stock market
Shelby Davis was a legendary investor who turned a $50,000 account into a $900 million fortune over his lifetime. The secret to his success was not finding a few outstanding companies and betting big on them but instead, investing a few companies every year or so and then holding them forever.
Shelby rarely sold any of his positions and his portfolio had over a 1000 different stocks in it. Another of his trait was to stay close to his area of comfort, or in industries that he understood well. He invested a great deal of his portfolio in insurance stocks. He rode AIG for a huge profit from the very beginning of the company.
What is Free Cash Flow? and why do we care?
Free Cash Flow is defined in a number of different ways as there is not a clearly defined term under the Generally Accepted Accounting Principles (GAAP).
I am going to attempt to explain Free Cash Flow in the best way possible but first why do we care about Free Cash Flow?
In simple terms Free Cash Flow is what is left over after a company pays all cash expenses and makes investments in capital equipment and working capital. So FCF (Free Cash Flow) is after tax cash flow available to all investors.
The way I learnt to calculate Free Cash Flow is start with the revenue and deduct all operating costs, arriving at operating profit. We then apply the tax rate to the operating profit. This gives us the net operating profit less adjusted taxes. To obtain FCF, we add back non-cash operating expenses, then deduct capital expenditures and investments in working capital.
Why do we care about FCF?
Free Cash flow is available to all claimholder’s on a business, both debt holder’s and shareholder’s. We care about Free Cash Flow because it helps us determine the value of company. Free cash flow or FCF helps us calculate the intrinsic value of a company, which we derive by calculating all future cash flows of the company minus the average cost of capital. So if you can buy the shares of a company at a discount to the intrinsic value, you are almost certain to make a profit.
I have learnt a great deal about this topic and other finance topics from the Motley Fool website and from the community boards. There is a lot of talk about Free Cash Flow at the Motley Fool website. Check out the following article on Foolish Fundamentals: Free Cash Flow.
Diversify, Diversify, Diversify
What is the perfect number of stocks to hold in a portfolio?
In my humble opinion, there is no perfect number, it truly depends on the individual and their level of confidence in their own analysis.
For me that perfect number of individual stocks is 20. I will explain how I came to this number in a minute. But first, a Buffet quote to get us started.
"Wide diversification is only required when investors do not understand what they are doing"
Investor's with Warren Buffett's investment acumen can really get a bang out of their buck by only investing in a small number of securities, but for the rest of us, diversification is a necessity. Although, too wide a diversification can work in the opposite way and truly dilute the returns of a portfolio.
So how do you figure out what your magic number is? First you have to agree on the amount of time you can truly spend researching and analyzing the investments that you are going to be investing in. The magic number for me is 20. I can reasonably manage to read about and keep up with about 20 securities.
Here is how I have structured my portfolio. I invested 30% of the total portfolio in the Vanguard Total Stock Market Fund (VTSMX). Since this fund invests in the total stock market, this gives me immediate diversification. The next 10% of the portfolio is in cash and invested in a money market fund. The remainder 60% is invested in 20 stocks, that include blue chips, small caps and mid caps. This comes to an individual investment of only 3% percent in any one company. This gives me a cushion in case one of my stocks take a beating in the short term. If this happens I use the cash in the portfolio to add to my position, bringing down my cost per point on the security.
Here is how the investment portfolio breaks down:
VTSMX 30%
CASH MONEY MARKET 10%
Individual Stocks (20 stocks) 60%
______
Total 100%
